Illustration: Colin Daniel

Pyramid schemes in South Africa are more likely to collapse than be shut down, thanks to regulatory arbitrage. The National Consumer Commission (NCC) this week said it was no longer pursuing an investigation into nine suspected pyramid schemes. It said the police’s Specialised Commercial Crimes Unit has taken over the matter.

The NCC was established in terms of the Consumer Protection Act (CPA), which defines and outlaws pyramid schemes. However, the commission doesn’t have the capacity to do forensic investigations, Trevor Hattingh, NCC spokesman, says. And only legitimate businesses can be taken to the National Consumer Tribunal, he says.

Hattingh was responding to questions about reports this week that the NCC has concluded a preliminary investigation into nine suspected pyramid schemes and subsequently handed them over to the commercial crimes unit.

“Fraud can be investigated only by the police. We assisted them in identifying the characteristics of a pyramid scheme … but only legitimate businesses can be taken to the tribunal,” Hattingh says.

The tribunal was established to adjudicate on allegations of business practices that are prohibited in terms of the CPA and the National Credit Act. Applications can be brought by the NCC.

The NCC investigation into the schemes began last year and stemmed from concerns raised by the South African Reserve Bank and the Financial Services Board (FSB).

Wouter Fourie, the 2015 Financial Planner of the Year and chief executive of Ascor Independent Wealth Managers in Pretoria, says that until the Financial Sector Regulation Bill – also known as the Twin Peaks Bill – is enacted and existing regulatory gaps are closed, consumers will continue to be defrauded and those operating pyramid schemes will continue to get away with it.

“I’ve had experience of trying to lodge a complaint with the FSB only to be told that it doesn’t have jurisdiction over entities that aren’t registered [as financial services providers].”

Fourie says informed and high-net-worth investors are among those who have put money into the likes of Kipi, also known as Mydeposit241, one of the schemes that the NCC investigated.

Fourie, a Certified Financial Planner and professional accountant with a post-graduate diploma in advanced taxation and investments, says a client who approached him for tax advice had “invested” in Kipi and last year invited Fourie to address an investment club of which the client was a member.

“All the members of the club had put money in Kipi and didn’t know how to deal with the income they had received.

“I was shocked! ‘Are you stupid? Where is the income generated from?’ I asked. He didn’t know, so he arranged for me to meet someone from Kipi. When I questioned him about the assets used to generate this huge income, the guy got very aggressive, because the money is derived from other so-called investors,” Fourie says.

“Money is ‘donated’ by you to fund a portion of somebody else’s ‘dream’, with the expectation that others will in turn ‘donate’ money to fund your dream. It’s like taking from Thabo and Tannie Susan to pay Peter. The only way this can work is if you recruit more people to ‘donate’ to keep funding the dreams of the people already in the system. This pyramid will tumble as soon as the new recruits dry up. It might work for a year or even longer, but the longer it goes on, the bigger the impact will be on those who join last. It is a crash waiting to happen.”

As for making “donations”, Fourie reminds participants that these must be declared on your tax return and attract donations tax of up to 20 percent (subject to annual exclusions).

In case you think that paying tax on donations to such schemes puts you on the right side of the law, think again. The CPA says that a person must not directly or indirectly promote, or knowingly join, enter or participate in a pyramid scheme, or cause anyone else to.

A key feature of a pyramid scheme is its dependence on the recruitment of new members, rather than the sale of a product or service or any investment, to generate money. There may be a product, but it’s usually a by-product and not the main source of income for the scheme.

Pyramid schemes are often disguised as multi-level marketing schemes, selling legitimate products or services, Lyndwill Clark, the head of consumer education at the FSB, says.

“However, the promoters of the investment use money collected from new recruits to pay off early investors until eventually the pyramid collapses. At some point, the schemes get too big and the promoter cannot raise enough money from new investors to pay earlier investors and people lose their money,” Clarke says.

Fourie says that once investors receive a benefit, their involvement in the scheme becomes like gambling. “They go back for more, thinking ‘just one more’ … and keep going back for more.”

Those who induce friends and family to join, knowing full well that it’s a pyramid scheme, are putting those people at risk of losing their money, as well as anyone else they, in turn, recruit.

“People are lured by someone they trust – someone in their network who has had experience of a payback. Investors reckon more and more people are doing it, so why is it wrong? And at presentations, they claim it’s a worldwide movement, which seems to lend a degree of credibility,” Fourie says.

The other schemes the NCC was investigating were Direct Intervention Program to Empower South Africans (Dipesa), Instant Wealth Club, Make Believe, MMM South Africa, NMT Investments, Sikhese, Wealth Creation Club and WorldVentures.

In December last year, Dipesa was issued with a letter of exoneration from the NCC. The letter was mailed to the media by Dipesa chief executive Henk van Zyl. In it, commissioner Ebrahim Mohamed states that Dipesa “appears” to be running a legitimate business.

The person answering the phone at Dipesa this week said the company sells “vendor phones”.

Kipi claims that it doesn’t collect funds from members; it facilitates donations. Once you’ve made a donation towards someone else’s dream, your dream starts accumulating earnings, which are paid out on maturity date.

According to its website, the company makes a profit by trading bitcoins on trading platforms and sharing it with the community.

MMM, which claims to be a community of people who help each other, also states that it doesn’t collect money: funds are “transferred to participants”.

“MMM is not a bank, MMM does not collect your money. MMM is not an online business, investment or multi-level marketing program. MMM is a community where people help each other … for FREE,” according to its website, which is almost nonsensical in places. “All transferred funds to another participants are your help given by your own good will to another one, absolutely gratis.”

So how does it work? The site says: “You declare the willingness to give help, after which your account will be credited with mavro (internal currency of the system). Mavro amount will start growing from the moment of deposit at the rate of 30 percent per month. (Calculation of interest occurs twice a week.) This sum in mavro shows how much you can request yourself.

“Say, you have announced willingness to assist with $100. You will be credited … with 100 mavro. And they will immediately start growing! A month later, these 100 will become 130 mavro. Accordingly, you will be able to request assistance for $130.”

Russian fraudster Sergey Mavrodi is believed to be behind MMM South Africa. Mavrodi, whose mugshot appears on the MMM South Africa website, was convicted in 2007 by a Russian court for defrauding 10 000 investors out of 110 million rubles (about R520 million).

GENUINE STOKVELS ARE DIFFERENT

Kipi and MMM South Africa claim to be “stockvels” or communities set up to help their members. However, there are substantial differences between these schemes and genuine stokvels.

Genuine stokvels are “regulated by exemption by the South African Reserve Bank (SARB)”, Ben Raseroka, a trustee of the Stokvel Social Trust, says. (They would probably also know how to spell “stokvel”.)

“Because members contribute and pool funds, one may argue they are deposit-taking entities, which is strictly the work of a bank. To function as such, you would need a banking licence from the SARB. Stokvels are exempt from that.” But that doesn’t mean they aren’t regulated. In terms of the Banks Act, they are required to belong to the National Association of Stokvels in South Africa, a self-regulatory organisation which has been approved by the Registrar of Banks, or a similar body approved by the SARB.

A stokvel can be defined as a group of people with a common bond, Raseroka says. “A true stokvel couldn’t be made up of strangers. Members know each other personally. They may go to the same church or live in the same neighbourhood. What’s key is that they have a social objective. It may be to save for a holiday or to mitigate a risk, such as the high cost of a funeral. So they come together and each regularly contribute an equal amount of money over time,” Raseroka says.

“The underlying thesis of a stokvel is that it is based on some form of social solidarity, and therefore the pooling of funds is not strictly based on a financial return,” he says.

A genuine stokvel is unlikely to generate a “profit” of 30 percent a month – as MMM claims it does – for a number of reasons, Raseroka says. “Firstly, a stokvel is not per se a business. It generally does not own a product or service that can be sold to the market for profit. Secondly, even if a stokvel were to decide to invest its pooled funds in the market or with a third party like a regulated financial institution, the possible ‘profits’ are only likely to be in line with the average returns received by the rest of the investing community.”

He says there are two types of stokvels: rotating and accumulating.

* Rotating stokvel: members contribute a fixed amount of money to a common pool weekly or monthly and take turns to receive a lump sum to use for any given purpose. Money is not banked – because it is paid out as soon as it comes in – and therefore doesn’t earn interest.

* Accumulating stokvel: members contribute monthly, but not necessarily the same amount. You may have to pay in a minimum of, say, R500 a month, but if you contribute more, your payback will be proportionally higher. The accumulated funds are distributed once a year to all members. Money is banked and attracts interest.

Stokvels are highly regulated within themselves: about 80 percent of them have a chairman, secretary and a treasurer and are governed by a constitution, Raseroka says.

If a stokvel wants to open a bank account, the banks require it to have a constitution that outlines the objectives of the club, specifies the minimum or maximum number of members, their duties, and how records are kept, among other things. The banks have also made it a condition that the stokvel has at least two members acting as signatories on the account.

Raseroka says one way of protecting investors from being conned into believing they are joining a stokvel would be to restrict the use of the word by giving it a legal definition. “Unless you fit into the category of a stokvel and have the salient features of a stokvel, you should not be able to pass yourself off as one,” he says.

HOW TO SPOT AN INVESTMENT SCAM

The tell-tale features of a scam are:

* It claims to pay out double-digit monthly returns;

* It claims to be an opportunity of a lifetime;

* There are no underlying investments;

* You can’t understand how it generates money;

* It is not a registered product or a product offered by an authorised financial services provider; and

* Returns or profits earned by you may be dependent on you introducing more members to the scheme.

Verify the legitimacy of a financial services provider before you invest by visiting www.fsb.co.za/Departments/fais/searches/Pages/providers or calling the Financial Services Board on 0800 110 443.

VARIATIONS ON A SCHEME

* Pyramid scheme. An illegal business model that recruits members via a promise of payments or services for enrolling others into the scheme, rather than supplying investments or selling products or services.

* Ponzi scheme. A fraudulent investment operation where the operator pays returns to its investors from capital paid in by new investors, rather than from profit earned by the operator.

Ponzi schemes usually entice new investors by offering higher returns than other investments, in the form of short-term returns that are either abnormally high or unusually consistent.

These schemes occasionally begin as legitimate businesses, until the business fails to achieve the returns expected. It becomes a Ponzi scheme if it then continues under fraudulent terms. The perpetuation of high returns requires an ever-increasing flow of money from new investors to sustain the scheme.

* High-yield investment programme. An online Ponzi scheme promising unsustainably high returns. Most of these scams work from anonymous offshore bases, which make them hard to track down. – Wikipedia